Canadian pension plans have taken a double hit from the recent market turmoil, losing money on their investments while simultaneously seeing their funding obligations grow thanks to falling bond yields.
Pension consulting firm Aon Hewitt estimates the average funded position of corporate pension plans in Canada fell from 97 per cent on July 25 to 85 per cent by Aug. 8 after stock markets went into a tailspin. That means plans have slid into a significant deficit after being close to fully funded, based on financial statement disclosure measures.
Pension funds have spent three years trying to climb out of a deficit left by the market downturn in 2008 and 2009, and have now faced a new blow that has unwound a significant portion of that improvement, leaving many in the same position they were at this time last year, said Aon Hewitt vice-president Tom Ault.
Aon Hewitt tracks the pension funding disclosed in corporate financial statements of all the companies in the S&P/TSX composite index that have traditional defined-benefit pension plans for employees. It estimates how the plan funding has shifted during the year based on changes in investment categories such as stocks and bonds.
The results show pension plans have been “on a roller coaster,” Mr. Ault said, with high volatility and daily swings of more than two percentage points in their funded position on many of the days in August so far.
“On a daily basis at the moment things are changing quite a lot,” he said.
The volatility has been exacerbated because pension plans have seen asset declines coupled with a sharp jump in the size of their estimated cost to fund pensions. Pension liabilities are calculated using bond yields, which have slid sharply since July.
Government of Canada bonds with maturities over 10 years have seen their average yield fall from 3.47 per cent at the start of July to a low of 2.88 per cent on Aug. 10 and were back up to 3 per cent by Tuesday. A general guideline in pension accounting is that a percentage point drop in bond yields boosts a plan’s liabilities by 15 per cent.
Paul Forestell, senior partner at consulting firm Mercer, estimates typical pension funds have seen their funded status slide by 10 percentage points since the beginning of the year on a solvency basis, which is the regulatory ratio used to determine whether companies are required to inject more cash into their pension plans.
He said a typical pension plan started the year with assets equal to about 90 per cent of liabilities based on a solvency basis, and is now down to about 80 per cent funding. Pension plans have not lost all the gains they’ve made since 2009, Mr. Forestell said, but it could still happen.
“If the turmoil continues and there continues to be declines in bond yields, we could get back to those levels,” he said.
While companies will not have to calculate their exact pension hit and crystallize the losses until their financial year-end, Mr. Forestell said most are closely watching their pension plans to prepare for possible problems. “Right now it’s concerning, and people are looking at their budgets for 2012.”
The hit facing companies this year is expected to be worsened by new global accounting standards that Canada adopted last Jan. 1. The rules will not permit the same sort of “smoothing” that was done in the past, by which companies could slowly record the hit to their balance sheets from soaring pension liabilities over a number of years.
Narrower standards eliminating smoothing are expected to take effect in 2013, said Eric Clark, a partner at PricewaterhouseCoopers Canada. But some companies are already adopting the new rule, which will worsen their balance sheet valuations of their pension shortfalls.
“You may see some of that balance sheet volatility [this year]” Mr. Clark warned.
The full extent of the impact will depend on the degree to which individual pension funds have moved to reduce their exposure to stock markets and lessen their risk of volatility.
Jean Bergeron, a partner at pension consultants Morneau Shepell, said most pension plan sponsors he works with have been changing their investment strategies to try to reduce volatility after learning a sobering lesson in the 2008 market crash, so some may not be as hard hit as others.
But he said it is difficult for plans to fully insulate themselves against market volatility and many were making the changes slowly as their financial health improved, so they hadn’t yet reached their targets.
“Unless the markets rebound, it’s going to be a very difficult year for pension funds,” Mr. Bergeron said.